[Flashback] Behind China’s Corruption Crackdown: Whistleblowers

http://www.forbes.com/sites/riskmap/2015/02/12/behind-chinas-corruption-crackdown-whistleblowers/

Posted by KOH Ngiap Hao, Year 4 undergrad at the School of Accountancy, Singapore Management University

A top concern for most multinational companies doing business in China the last year has been the Chinese government’s dogged crackdown against corruption. Ask CEOs in China what wakes them at 2 a.m. in a cold sweat and their answer is simple: the dreaded “dawn raid.” What is less widely known is the outsized role that whistleblowers have played. Almost every major fraud or corruption crisis faced by multinational companies in the past year kicked off because of a whistleblower allegation. According to Chinese officials, four out of every five anti-corruption investigations are initiated by whistleblowers. Often these are former and disgruntled employees, suppliers, distributors, consumers, scammers and competitors—some complaints are legitimate, others not.

Whistleblower complaints in China have historically been an internal matter; any reports were logged with senior management and subject to internal investigations. But there has been a significant trend toward reporting—or threatening to report—directly to Chinese regulators. Whistleblowers are discovering the power of involving regulatory authorities in China to help them achieve their objectives, which range from reporting and rectifying a genuine integrity and governance issue, to extortive attempts to extract monetary or other concessions from management, or simply to take revenge following disputes. In the new, turbo-charged China environment for regulatory oversight, such whistleblowers represent a significant source of risk for multinational corporations.

Several market dynamics have converged to create this perfect storm of opportunity for whistleblowers in China. They include an uptick in regulatory enforcement, a slowing economy and new pressures on investigators.

Regulatory oversight and enforcement began to increase in 2013 and shows no sign of down. Regulators that were quite passive in the past will maintain their more active and aggressive stance, and multinationals are on their collective radars. China’s political leadership has provided a mandate for regulator activity and we will continue to see high levels of enforcement, particularly in the key sectors of healthcare, automotive and consumer products, with likely increasing enforcement in energy, telecoms, infrastructure and real estate.

The slowdown in the Chinese economy means two things. First, companies are not hiring aggressively and employees find it harder to seek alternative employment. Second, companies are restructuring commercial agreements with distributors and suppliers who are feeling the squeeze on their own business. The combined effect is that both employees and third parties have additional incentive to leverage information of potentially unethical or illegal activity. Threatening to blow the whistle to regulatory authorities is an often-successful way for them to retain their positions, even if they are themselves complicit in the activity they are threatening to report.

Meanwhile, Chinese regulators are under pressure to deliver results. Pressure to resolve a case with a finding against a foreign company may come from the whistleblower, the media or their own peers; regardless of the legitimacy or accuracy of the claims being made. Within agencies, investigators have additional pressure and targets from their bosses. They will often confront the company with allegations taken verbatim from a whistleblower letter, typically without performing much (if any) due diligence on an allegation’s veracity.

It often unfolds like this. A company is approached by a mid-level regulator with vague allegations of “impropriety.” The company might be told that “we have information that one of your distributors is taking bribes” and will be asked to investigate itself and report back to the authorities on the findings. The company will not be shown any specific evidence nor will it be given any legal basis for the regulator’s suspicion – but will often be threatened with legal or administrative action if it doesn’t cooperate (fines, loss of license, employee detentions, etc.). In many cases, regulators return the results of a company’s own investigation with additional “guidance” on other areas to examine, until the company presents the desired investigative findings and evidence: this is often what is meant by “cooperating with the authorities.”

So what can companies do to limit their own risk of a regulatory investigation? It starts with thinking through the processes they use to accept and process whistleblower allegations. Getting ahead of any allegations and proactively correcting any perceived wrongdoing can help to stave off a visit from the regulators. Best practice in China includes four items:

•Understanding the regulators: Nearly every company’s stakeholder map in China has changed drastically in the past two years, so it is critical to take a fresh look at the broad spectrum of regulators against a given business and identify which regulators would be legitimately interested in what parts of the business. For example, a company that relies heavily on third-party distributors to sell to customers will be vulnerable to allegations of bribery and corruption, which would be investigated by local Administration of Industry and Commerce (AIC) offices to investigate. Companies with a fragmented business structure and many sales offices in China may get called out on not paying the proper amount in local taxes, resulting in a State Administration of Tax (SAT) visit. For each type of allegation, a company can identify which regulator might be interested and how active they are in each province where the company operates. From there, a company can begin to understand what the regulators look for and how they operate, and get ahead of any allegations of wrongdoing.

•Create a feedback loop to in-country management: Whistleblower allegations should be handled by a neutral party, not by the operation against whom the allegations are leveled. However, this does not mean a multinational company should keep its China management team in the dark about allegations of wrongdoing in China. In-country managers need basic information in order to monitor the risk of whistleblowers reporting to local regulators. Too often, an office in China will be dealing with a regulator but have no idea that an allegation along similar lines was made to their head office whistleblower hotline a few weeks earlier. Tracking allegations over geography and time is also essential. Companies who log and track the details of whistleblower complaints often see patterns that can be dealt with; ahead of any regulator getting involved.

•Investigate outside the four walls: All whistleblower allegations should be thoroughly investigated; a simple “audit” will not suffice. Looking outside of their own books and records allows companies to trace allegations back to activities of third-parties and other outsiders. Any confirmatory evidence of conflicts of interest or collusion will not be found within a company’s four walls.

•Don’t give in to extortion: Companies that receive an extortive threat to report information to a regulator must resist the temptation to immediately concede to any demands. It may seem like an effective short term solution, but there is a very high risk that it comes back to cause bigger problems in future. It is critical that multinational companies cooperate with Chinese regulators and one’s “attitude” will be important to reaching a conclusion; however, there are many ways to be “cooperative” and companies should consider all scenarios before responding.

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